Gold, Dollar and the S&P

Looking at Gold and the Dollar as compared to the S&P 500, you could make an argument to support that the market is making a possible top right now.

Gold made a high on December 7th and has since traded down a bit into a possible bear flag formation. You could argue that if the markets are following Gold's lead and gold is about to make a further push down, then this new high on the S&P could mark the beginning of a reversal down. Also, if you look at the dollar, it made a high on November 30th. This coincides with the beginning of the current short term rally in equities. The dollar has since traded down to its most recent higher low on December 5th and has since been making higher lows. You could argue that the dollar will continue up since it found support at the 20 MA on the daily chart on December 5th. For this you could also argue that equities will trade down in concert with the upward trend on the US dollar.

What is also significant is that the average number of daily gainers versus daily losers in stocks is trending down amidst this current rally, another sign that the rally is coming to a short term end.

These are all reasons to allow you to speculate a top is forming. However, if you prefer, you can wait for confirmation that the current up-trend is broken before going short. To do that wait for consecutive candle closes below the upward trending 8 and 20 period moving averages; on the ES, you would want to wait for confirmation below 1231-1232 intra-day and/or below 1217-1218 on the daily chart...

How Much Higher Can We Go?

The market continues to be in Bull mode, however, that doesn't mean it will continue up. We have essentially been consolidating for the past six trading days while making slightly higher highs in the process. The obvious thing to note, though, is that the new highs are met by selling every time. This trading behavior that appears to be bullish consolidation, is trade that happens to occur in a resistance zone dating back to the 2008 lows. There is still potential to make higher highs, but that upward potential is limited as we will likely see a correction in the near term.

We have been seeing some good news of late including high consumer sentiment numbers as well as a decrease in unemployment claims. This good news coming at new two year highs in the market could be just the type of deceptive info that could make this a good time to sell.

How much can we correct?

I have a couple of key levels on the ES to look at and I will list them as targets to the downside:

Target 1: 1194-1197
Target 2: 1182-1183
Target 3: 1155-1160

Target 3 may be less likely, but if you trade multiple contracts, you can attempt to scale out of your position at each target, letting the last (1/3 position) ride in case the ES continues down lower than targets 1 and 2.

The key is determining where to enter the short position. I wouldn't argue with entering a short now in the current range between 1230 and 1233. Just be aware that there is further upside potential. That being said, I don't expect the ES can trade higher than 1240-1245 without correcting.

Take precaution. When shorting into a bullish market trend, it is important to consider hedging your trades. One way I like to hedge my short bets, is to take scalp trades (in a separate account) to the long side on each down-tick into support.

So, to recap, I expect a downward correction anywhere from 40 to 75 points. It is possible that this correction does not happen until after the new year, but I expect it sooner. After the down move, look for the bull market to continue and expect new highs into 2011...